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October 24, 2013

In Competitive Stroke, Fidelity Launches Low-Cost, No-Commission ETFs

Fidelity has also filed to offer five actively traded fixed income ETFs.

(Photo: AP)

Fidelity Investments announced Thursday that trading began on 10 new Fidelity sector equity ETFs based on MSCI indexes and subadvised by BlackRock.

Each ETF has an expense ratio of only 12 bps, which Anthony Rochte, president of SelectCo, the company’s dedicated sector investing division launched last year, said were the lowest in the industry. The ETFs will also trade without commissions for advisors using Fidelity’s RIA and National Financial’s trading platforms, though individual broker-dealers might impose their own ticket charges for trades.

In an interview with ThinkAdvisor, Rochte (formerly of State Street, a big player in sector ETFs) said the move was initiated in part by the changing way that advisors and end investors are building portfolios past the 2008-2009 crisis, with a greater focus on downside protection and on sector and industry investing. “Our focus is to capitalize on that in two ways,” Rochte said, through Fidelity’s 44 active sector mutual funds, which he said have seen consistently strong inflows, and through this new suite of “building-block passive ETFs.”

In addition to the equity sector ETFs, Fidelity has also registered with the SEC to offer a suite of five actively managed fixed income ETFs which when launched will be managed by Fidelity’s Fixed Income division. That reflects the fact that “SelectCo is not the ETF offering for all of Fidelity—there’s no standalone ETF business within Fidelity,” Rochte said.

While Rochte wouldn’t speculate on whether international or global ETFs were on the drawing board, he did say that with its partner BlackRock it was exploring additional active and smart beta products. Referring to SelectCo, Rochte said that “if we’re going to build a successful division, we need to offer both” active and passive vehicles.

Todd Rosenbluth, director of ETF Research at S&P Capital IQ, said in an interview with ThinkAdvisor that the Fidelity announcement is a major one that will competitively affect not only other ETF providers, but “also those with ETF platforms” offering commission-free trades for advisors, such as Schwab and TD Ameritrade.

Asked whether it will impact State Street’s sector ETF business, Rosenbluth said, “I think it impacts State Street to a lesser degree” than other ETF providers such as Vanguard, partly because State Street’s “sector SPDRs are so widely used and liquid.” Because of those factors, “it’s hard to compete with the SPDRs; it hurts them less than Vanguard.” By contrast, “iShares gets a partial benefit from being tied to the 65 Ishares” that are already offered commission-free on Fidelity’s platform. “It makes Fidelity’s platform better, so more advisors may choose to work with Fidelity.”

Many advisors, Rosenbluth says, “know Fidelity from a research standpoint,” so being able to trade the new ETFs may well “give them different exposure to Fidelity,” since part of Fidelity’s apparent strategy is to “educate them through sector investing.” Noting that given the “amount of money going to sector ETFs; they’ll join that conversation,” With the move, Fidelity “seems to be combining their research with their ETF strategies more closely.”

Rochte said that advisors tend to use a core of mutual funds but also ETFs in client portfolios, he cited a recent Fidelity research paper that showed the importance of sector investing as a source of investing returns; sector investing was second only to “finding the right stock.” That paper and a number of other written research reports exist on a special minisite on the Fidelity advisor site.

As for using MSCI indexes for the new ETFs, Rochte said that “what we heard clearly from intermediaries” is that they want the GICS—Global Industry Classification Standard—developed by MSCI as the basis for ETFs.

In addition to the MSCI indexes for the ETFs (see a list of the 10 below, with their tickers), Rochte expects advisors to be attracted by the new ETFs’ low costs, saying that their management fees are “80% lower than the sector industry ETF average.”

S&P's Rosenbluth acknowledged the appeal of the Fidelity ETFs' low costs, but cautioned that there are "nuances" among all the sector ETFs in the market including cap weighting, and that "cheaper isn’t always better."

As for its overall ETF strategy, which includes the five active fixed income ETFs that Fidelity has already filed to offer, Rosenbluth said, “they’re going to be doing fixed income in-house,” and he says Fidelity may well offer smart beta ETFs as well, similar to Schwab’s fundamental indexing ETFs. It’s there, he suggests, that Fidelity “may be where they hope to differentiate themselves.”

While Rochte declined to provide an asset goal for the new ETFs, he noted that ETFs are a $1.5 trillion industry ($1.44 trillion as of 6/30/13, says Nasdaq), though with “growth of 27% CAGR,” which while paling in comparison to the $13 trillion mutual funds nevertheless are part of an important solution for advisors’ portfolio building needs.

However, he argued that “mutual funds are the most appropriate vehicle in 401(k)s,” since in such qualified plans there is usually no need for intraday trading and since ETFs are for the most part already highly tax efficient.